Place your bets on “Blue Chip Biotech"

09.06.2009

Andreas Burckhardt, Analyst WestLB

From a portfolio perspective, what a party we’ve had with the relative out-performance of European biotech companies versus the general equity markets in 2008, all the way up until early March this year! Although the industry also had a better run compared to its US peers (outperforming the AMEX and Nasdaq Biotechindex by 5% and 9% respectively in 2009), the situation has changed. It now seems the equity festivities have moved elsewhere. Since March, investors have been buying into the early signs of an economic recovery – that still lacks conclusive evidence – by switching into cyclical and financial stocks, and are shunning the biotechs. This in spite of the fact that on the scorecard, all the important indices (the DJ Stoxx, the S&P 500 and the Nasdaq) achieved stellar gains of 35% and more, while biotech performance in the EU and US stood at +15% on average.Although the European biotech sector in general was not everyone’s darling in Q2/2009, we noticed a new stock-picking approach amongst investors. This was primarily seen in small cap stocks with a market-capitalisation of less than EUR50m – a designation that includes around half of the 132 listed firms in Europe. There some highly speculative buying activities in almost illiquid stocks caused hiccups of up to 250% returns, in many cases even without relevant news-flow. This happened especially in the UK and Norway, where performance lagged last year compared to the rest of Europe. Unfortunately, these investments did not mean institutional investors are back. Instead, the feeling is more like that at a roulette table. The gambling makes us uneasy, as two thirds of all small cap companies will face major funding problems within the next 12 months, and most don’t have a convincing survival plan. That said, it’s good to see that two-thirds of all listed European biotech firms have produced absolute returns so far in 2009, albeit at very low levels.There is reason to question whether these are healthy signs of a new and sustainable trend. Cash is king, and it will remain so for both investors and companies. Unless we see a broader inflow of money into equities from asset managers or insurance companies regarded as generalists, life in the biotech sector will remain chancy. Due to the mixed picture in terms of product development (think prominent failures at Cytos or Santhera) and the absence of any takeovers in the large- and midsize area this year, the biotech sector is not yet attractive enough to initiate high-quality investment in the short-term, despite low valuations – one reason to expect the cry for government help from all over Europe to increase steadily in volume. Only in countries where local governments set up rescue funds are we likely to see strong rallies. In the meantime, we re­commend sticking to “Blue Chip Biotechs”, like Actelion, Qiagen or MorphoSys, which are undervalued and should benefit when stock markets go on the defensive again during the next market consolidation.

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